Is it suitable for your local governments? A contingency theory-based analysis on the use of internal control in thwarting white-collar crime

DOIhttps://doi.org/10.1108/JFC-10-2019-0128
Published date11 March 2020
Date11 March 2020
Pages770-786
Subject MatterAccounting & Finance,Financial risk/company failure,Financial crime
AuthorNanang Shonhadji,Ach Maulidi
Is it suitable for your
local governments? A contingency
theory-based analysis on
the use of internal control in
thwarting white-collar crime
Nanang Shonhadji
Department of Accounting, Sekolah Tinggi Ilmu Ekonomi Perbanas Surabaya,
Surabaya, Indonesia, and
Ach Maulidi
Business School, University of Edinburgh, Edinburgh, UK and
Department of Accounting, BINUS Graduate Program,
Bina Nusantara University, Jakarta, Indonesia
Abstract
Purpose The purpose of this study is to extend existing theory by developing a contingency theory for
the public sector and to provide a landscape for local government to deal with white-collar crime. In recent
years, the theme of risk management and internal controls, which is popular in the industry and private
sector, has been mirrored by public sector organisations. Of course, it is to improve fraud risk control
systems. We have to accept that public sector organisations have a growing need to control the (frau d)
risks in a rapidly changing economic environment. Within this situation an effective internal control is
becoming strategically important in many organisations, as it is proving to be a cost-eff‌icient way to
manage these risks in ev eryday operations. He re, the authors condu cted a case study on the ri sk
management control system at an Indonesian local government.
Design/methodology/approach This study uses mixed methods, integrating quantitative and
qualitative data in-depth interviews and questionnaires were required to address the social phenomenon
being investigated.
Findings This study found that the structure of the control system f‌its a generic model, in which control
systems are fundamental factors to alldepartments. It shows that control systems can support managers to align
employee capabilities, activities and performance with the organisations goals and missions. In addition, the
authors could identify, risk assessment and monitoring activities are effective measures of controlling
organisations activities, and potentially could diagnose potential (fraud) risks, deterring to the achievement of
organisational aims. Ideally, those aspects should be performed on a continuous basis if organisations wantto
prevent the spread of numerous potential menaces. In other words, if an organisation fails to carry out risk
assessment correctly, it will result in unidentif‌ied possibility of fraud risks. The more explicit ther isk assessment,
the more effective the detection of fraud.
Practical implications It can be alternative to considerCommittee of Sponsoring Organizations of the
TreadwayCommissions internal control as fraud mitigationin local government.
Originality/value This study offers new directive discussionabout internal controls as notion of fraud
mitigation.
Keywords Internal controls, Contingency theory, Local government, Fraud risk
Paper type Research paper
JFC
29,2
770
Journalof Financial Crime
Vol.29 No. 2, 2022
pp. 770-786
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-10-2019-0128
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1359-0790.htm
Introduction
The existence of internal control, within local government, has overarching factor in
achieving organisations objectives and thwarting f‌inancial crime. Many professionals
mentioned it is, in the daily conduct of business, def‌ined as a useful point of reference
when considering an organisations risk management framework (Committee of
Sponsoring Organizations of the Treadway Commission, 2013). Without any mitigation
action, the tactics and modus operandi used to produce fraudulent prof‌its can be much
more complex. This is substantially evidenced by cases occurring in local governments
around the world, for example, cases happening in UK. A local government auditors
report as stated in BBC (2013) News highlighted cases of suspected fraud; it shows the
average loss from each fraud case in U K public sectors rose by 15 per cent. Then, in
Wales, an investigation in Bermuda Government uncovered a series of bogus
payments. An investigation report released by BBC (2018) News mentioned the
ultimate cost of the fraud was estimated at £1.3m. In these cases, the suspects are
accused of laundering proceeds of £1.7m ($2.4m), which was to spend on a lavish
lifestyle.
Separately, United States Government Accountability Off‌ice (2016) reported that the
governmental improper paymentsremained increase signif‌icantly than previous year, from
$137bn in 2015 to $144bn in 2016. Approximately $44 and $34bn of the government-wide
improper payments happening in 2016 are caused by insuff‌icient documentation and the
inability to authenticate eligibility. These cases provide a framework for the discussion of
the likelihood of errors and fraud which are caused by administrativetasks. Practically, this
supports a regular study completed by Association of Certif‌ied Fraud Examiners (ACFE)
(2018), documented that a lack of internal controls is cited as the primary factor for
dishonest people to steal assets, engage in corrupt business practices and manipulate
organisationsf‌inancialstatements.
Although there is considerable research on fraud prevention, focused on governmental
sectors (Smith, 2008;Doig and Macaulay,2008), there is little attention on the eff‌icacy of the
updated internal control integrated framework released by the Committee of Sponsoring
Organizations of the Treadway Commission (2013) . In fact, it has been widely used by
private sectors listed in the USA and Japan as a control for managing the complexity and
pace of changing business environmentand potential (fraud) risks (COSO, 2013). To date a
conceptual discussion on internal control as anti-fraud measures is required. As any
organisation knows, advanced fraudsters are constantly f‌inding new ways to perpetrate
fraud. Importantly, this study is to answer a research call mentioning that there is no
evidence or little evidence on the mechanism linking internal control and substantive
procedures to reduce fraud or employee theft in organisation (Donelson et al.,2017).
Conceptually, this study uses the COSO revised internalcontrol framework that still keeps
the originals core components of internal control control environment, risk assessment,
control activities, informationand communication and monitoring and its three objectives
of internal controloperations, reporting and compliance.
Numerous studies treat the COSO framework as features of corporate governance (Martin
et al.,2014;Jokipii, 2010); most such studies emphasise the a chievement of an entitysmission,
strategies and related business objectives. Then, another study concentrates on the purely
f‌inancial reporting (Altamuro and Beatty, 2010). Little research considers the relationship
between the COSO framework and cases of fraudulence and dishonesty in government sectors.
In some cases, there is a continued expectation from public sector organisations about
preventative measures to address organised fraud (Doig and Macaulay, 2008). According to a
regular study completed by Association of Certif‌ied Fraud Examiners (ACFE) (2018),
A contingency
theory-based
analysis
771

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